Megan Greene, who is an external member of the Bank of England Monetary Policy Committee and, as such, one of the people responsible for setting UK interest rates, has written in the FT this morning, saying:
The most obvious way the UK economy differs is much more constraint on the supply side. The Monetary Policy Committee (MPC) recently estimated potential growth of 1 per cent this year, rising moderately to 1.3 per cent by 2026. The Congressional Budget Office (CBO) estimates US potential growth of 2.2 per cent over the same period. This means the US can withstand more demand in the economy before it turns inflationary. While the UK has long lagged behind the US in potential growth, the difference became much starker during the pandemic.
The claim that Greene is making here is that there remains a significant risk of inflation in the UK because we do not have the productive capacity to increase the supply of goods and services in the UK to meet any additional demand, if it were to arise. As such, her argument is that the Bank of England must continue to impose austerity upon the economy through the imposition of high interest rates to prevent that chance of additional demand occurring.
This is an extraordinary, and deeply perverse, argument, with an enormous sting in the tail in it.
The perverse argument is that the Bank must not permit growth because there is some inflation risk if it happens. It cannot be sure that this is the case, but it believes it must act anyway.
On the other hand, it is knowingly and perversely imposing a policy that can only impact upon those who happen to suffer the misfortune of having their fixed rate mortgages come to term, meaning that they must be renegotiated.
In addition, and extraordinarily, the Bank is knowingly imposing a policy that has no impact whatsoever on most of the top 20% or so of income earners in society, almost all of whom have seen fair pay rises and have benefited from the additional investment income that they have enjoyed as a consequence of the Bank's interest rate policy, which has boosted their capacity for consumption expenditure whilst everyone else is suffering.
Put together, in that case, and as the IMF is recently pointed out, the prospect of this policy working is exceedingly limited, even if it were appropriate. The nature of our fix rate mortgage system means that the transmission rate for monetary and interest rate policies into the economy is incredibly slow, meaning that the chance of there being any significant economic impact on consumption as a result of high rates is marginal, but at the same time that policy does actually increase the likelihood that those who are always inclined to spend the most will continue to do so, directly fuelling inflation as a consequence.
It is, however, the sting in the tail that is most important here. Megan Greene is typical of the current batch of external appointees to the Bank of England MPC in being particularly hawkish with regard to interest rates, meaning that she is very inclined to keep them high. Not only does this not work, it also inappropriately increases government costs, denying it the opportunity (presuming that you believe in Rachael Reeves' fiscal rule) to stimulate the economy.
In addition, it imposes additional cost on any business intending to invest, which is the hope on which Rachael Reeves has pinned her whole economic policy when she demands that the private sector must grow before she can take any action to relieve austerity. As a result, as things stand, the Bank of England is promoting policy that is bound to undermine any chance of Labour's hoped for growth, shattering all that it has to offer the country at a stroke.
Far be it from me to say that Labour is misguided in placing its hopes in City grandees. Instead, let me simply point out that at present many of them appear deeply opposed to what Labour is seeking to do. In that case, something is going to have to give. I cannot see the City grandees changing their minds. So, the question is, will Labour? If they don't, they have almost no chance of success with the policies that they have currently set out.
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Am I missing something? If the country knows that demand will increase, then it can plan for increased supplies thereby keeping inflation down.
You would have thought so, but markets can’t be trusted……
At least, I think that’s the message
More or less what I was thinking. Surely Increasing interest rates has the effect of depressing the kind of investment that would increase supply. Greene typifying the kind of narrow, short term thinking that typifies what I now think of as the ‘chicken’s entrails’ school of economics. Has she ever met a real business, consumer or mortgage holder?
Probably not is the asnwer to your last
I wonder, has she ever run a business?
Has she spoken to…….the power networks who claim that they need £50bn (or more) to accomodate renewables – of course that money if private comes with a cost – paid by UK serfs. What about water/sewage? = similar investment ball park, the list goes on & on. She makes a more than fair case for the abolition of the policy committee – or its wholesale replacement. They were never fit for purpose, useless theoreticians.
I really don’t think she has thought almost any of this through
Or rather, she has based on the assumption of ceterus paribus…which will fail her badly
I read this article earlier and I wondered if you might comment…. and of course you did.
In “econo-speak” she sounds plausible….. but in the real world it makes no sense and is a disaster.
In some sense she is right in identifying many problems that the UK economy suffers – and then comes up with the wrong solution. As you succinctly say she does not want to permit growth for fear of inflation.
But as several BTL commentators in the FT say, the evidence does not support this; we will have 1.xx% YoY inflation in about 3 months time – how does that fit with the “theory”?
I would rather think in the opposite direction to Megan Greene. With all the problems and headwinds facing the UK economy it needs a little bit of support and tenderness – ie. lower rates. We know that this will not be inflationary in the near/medium term….. and, in the longer term, we have no idea what the world will be like. As Keynes famously said “In the long run? In the long run we are all dead”. Unfortunately, this policy path is leading to suffering, even death, here and now… and for what?
Well put….
In the long run we are all dead …… maybe there is 10-20 years for us Baby Boomers, but Gen Z, millenials, etc., are all going to fry .. or drown…
Keynes did not anticipate climate change.
Sadly, all the emerging metrics are showing an accelerating rate of climate change, regardless of the El Nino cycle, and very probably with various tipping points being exceeded, or very close to being so.
Yet there is still massive growth in fossil fuel industries..
There really is a cartoon of lemmings watching humans jumping off cliffs.
We desperately need to mitigate climate change now as 1.5ºC has pretty much come and gone and sea temperatures signal further temperature rises.
Much of UK’s past success in reducing emissions came from converting from coal to gas for power generation, and outsourcing manufacturing to the Far East.
But we are not moving anywhere near fast enough at the present time.
If there is to be any growth in the economy at all , there is the absolute and urgent priority of both emissions reduction and mitigation of inevitable impacts by….
(and here’s but ten) ….
1. Repairing existing flood and coastal management schemes (22% at the last count in poor nick);
2. Habitat management of upland catchments to reduce lower course flood risks;
3. Managed withdrawal for some coastal communities;
4. Improved water storage to prepare for drought management;
5. Massively improving the insulation and draughtproofing of new and existing UK housing stock;
6. Real and compulsory energy efficiency training for building trades.
7. Growth in suburban rail services and network expansion;
8. More renewables infrastructure, and especially interconnectors in the national grid
9. 15 minute city planning. (though I think 20 mins is more practical)
10. Credible ‘degrowth’ or flatlining macroeconomic thinking and planning. Redefining growth is an imperative.
All these really require a war footing, and this is far from being an exclusive list.
Yet we do have an entire suite of solutions now, and do not need to rely on some nebulous hope of new tech fixes to get there.
None of these would be classified as ‘consumer’ growth.
Increasing personal borrowing and credit will not help muchly.
And there will be no small state, free market solutions.
Human civilisations will be utterly doomed with Austrian or neoliberal dogmas, as a collective resource management and problem solving approach is indispensable.
(This is why self proclaimed libertarians hate climate science).
There is no invisible hand.
All will need considerable state intervention, pump priming, and massive investment in infrastructure.
Meanwhile, the BoE are tinkering in the interests of the finance sector, and Reeves is tinkering in solely in the interests of achieving power, but without offering any credible propositions.
Faffing about whilst waiting for private sector growth or inflation below 2% is a chimera.
Or as the old joke goes, (monetary) beatings will continue until morale improves.
So, whilst BoE is thinking that there is only 1% growth potential in the economy, the government also complain that too many people are not in work. That looks like growth potential to me. Many people think chance would be a fine thing.
Why does the BoE take such a pessimistic view? Why not take a more pragmatic approach. Try growing the economy, spend more money, and see what happens. After all, the BoE track record on predicting inflation is hardly stellar.
Methinks they doth complain too much.
We had around 12 years of the lowest interest rates known and had very little growth to show for it. We were both there, although I’m not sure if we both remember that.
The view of the policy maker is logical as long as you understand the remit which is to ensure we have sound money in the UK, low inflation of around 2% in other words.
The BoE remit is not to support growth, provide growth, or prevent growth. That last can be perfectly well achieved by government all on its own.
Low interest rates and QE had a big imapct in growth – they prevented austerity delivering recession. The two neeted out. Don’t ignore the fact.
You are assuming the remit is right. It isn’t. The remit should be meeting all need in an environment of full employment on a liing wage with growth limited to that which is consistent with climate change.
So I do not agree with you.
All those years of low interest rates and still the private sector did not invest. Because the culture of the City is not about investment but about speculation. Which is why asset prices soared. Pumped up by QE. The government could have borrowed to kick start the economy and private sector money might have been dragged in to follow. As happened to a degree with renewables under the coalition – killed when the Tories regained full power.
Meanwhile austerity and flat wages for most people took money out of people’s pockets. Surprise, surprise, flat demand and minimal growth.
In the narrow economic world of the BofE, where all they really think about is inflation and the interest rate, nothing else matters. What Edward Heath I think, called one club golfing.
The UK’s “constraint on the supply side” is the result of chronic underinvestment, so its central bank is sticking to policies designed to deter investment. Wow. It’s what you end up with when you have class warfare posing as science.
Hopefully, Labour’s problems will be bigger than that
https://www.theguardian.com/politics/2024/apr/11/labour-may-fail-to-grab-target-seats-as-young-voters-turn-away-over-gaza-and-climate
Whilst large banks make half of their profit with no risk from the BOE there is no imperative for them to provide investment to firms, thus reducing growth potential.
Might it be worth considering an inversion of what seem moto be current B. O. E. attitudes and actions?
Thus, calculate the indicative costs of running, and bringing up to decent maintenance standards, all the infrastructures needed for a socially pro-active and profitable society and tax equitably and create enough money to achieve this, with appropriate inflation management.
Currently the B. O. E. Seems content to have some 25% of the nation’s children chronically/permanently underfed/starving for the sake of achieving arbitrary/theoretical numerical representations of our nation’s well being.
Might the quality of this thinking be about that of a farmer who decides to »balance the books » by not feeding his stock properly and is/alleges surprise when they fall ill and under productive?
I would love to see that estimate but cannot find it
I am trying to understand the implications of Greene’s intervention. The first point is that Greene is relying on a budget forecasting platform to know the capacity of the economy. On what grounds? The OBR are proven awful forecasters. On the basis of actual performance, they should be sacked, not followed. Only an economist (and politicians) would be foolish enough to pass their work. You cannot trust an official economic forecast of being a proof of truth ‘a priori’, they are too unreliable; and that is an incontestable fact. Second, what testable evidence can Greene offer that she can precisely measure the real capacity of the economy at a fixed time? Indeed what evidence does Greene possess that the “economic capacity” is accurately identifiable as a measurable fixed point?
Further, suppose you accepted Greene’s pretensions for the sake of the argument; this proposition suggests that in order to grow, you actually have to shrink the economy, and maintain the free unused capacity in the economy to be able to claim there is room to grow. The question arises whether Greene is not just advancing Zeno’s famous motion paradox; which of course it does not require a philosopher to see is a pradox of decomposition that is not in fact reproducable in the real world, when it is lifted off the page.